How to Utilize Exclusive Rights and Use Clauses in Commercial Real Estate From use clauses to tenant-landlord agreements, knowing your rights in commercial real estate is vital.
By Roxanne Klein Edited by Micah Zimmerman
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As an entrepreneur navigating the world of commercial real estate, you may encounter the terms "use clause" and "exclusive rights" embedded in retail lease contracts. Understanding these can make a significant difference in shaping the scope and success of your business. This article explores these concepts and why they're critical negotiation points for both landlords and tenants.
A "use clause" in a commercial real estate retail lease stipulates the exact type of business activity a tenant is allowed to engage in on the leased premises. This clause essentially defines and limits the commercial purpose for which the leased space can be used, whether it be a restaurant, a clothing retail store or an office space. Use clauses protect the tenant's interests by ensuring a suitable business environment, but they also safeguard the landlord's investment by avoiding incompatible business activities within the same property.
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On the other hand, an "exclusive rights clause" is a provision that protects a tenant from competition within the same commercial property or complex. For example, a coffee shop tenant might negotiate an exclusive rights clause that forbids the landlord from leasing other spaces in the same complex to competing coffee shops.
While these two clauses may seem interconnected, they serve different purposes and have distinct advantages and challenges.
For a landlord, granting a tenant an exclusive right may not always be in their best interest. There are a few reasons for this. Firstly, exclusive rights limit the landlord's flexibility to lease other units within the property to potential tenants offering similar products or services. This could potentially reduce the pool of prospective tenants and limit rental income. Secondly, the landlord may face risks if another tenant in the center violates the exclusion. Often referred to in leases as rogue tenants, the tenant attempting to get the exclusion from the landlord will often also attempt to put penalties if another tenant in the center violates their exclusive.
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In contrast, securing exclusive rights can be a powerful protective measure from a tenant's perspective. It eliminates the risk of direct competition within the same location, allowing them to maximize their customer base and profits within their immediate trading environment. This makes exclusive rights valuable in crowded and competitive industries like food services or retail.
A common compromise between a broad use clause and full exclusive rights is offering an exclusive regarding the primary use of the business. For example, a cookie shop tenant might be able to get an exclusive specific to a business whose primary use is cookie sales. Thus, the landlord would not be able to lease to two cookie shops in the same shopping center. However, if a restaurant in the same center has cookies as one of ten dessert options, that restaurant would still be allowed to sell cookies.
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It is important to note that when landlords do offer exclusions, they usually come with a caveat regarding the square footage. Back to the cookie shop example. Most cookie shops are usually between 1,200-1,400 square feet. Often landlords will grant an exclusive up to certain square footage. The square footage can be whatever number the landlord desires, but it is usually over 5,000 square feet. It would be rare to have a cookie store over 5,000 square feet. However, the landlords will typically have this large number to protect themselves from losing out on leasing to a tenant who would occupy a much larger space than the original tenant.
Along the lines of primary use, percentages are often seen in leases to assist in a compromise between a landlord and tenant. Let's say a tenant who is a boba shop has an exclusive of selling boba as their primary use, and the percentage of sales that comes from boba is 80%. The landlord might say in the lease that another tenant could sell boba if boba is less than 20% of their sales. Interestingly, these percentages are often in leases, while at the same time, it is nearly impossible for anyone to know exactly what percentage of items are being sold.
Landlords often attempt to negotiate that tenants need to report sales. Although when written, the entire number is being reported and not a breakdown of different items sold, the sales figures are being reported to help landlords know if any of their tenants might be doing poorly.
As a tenant, you can always try to negotiate not to report sales. Landlords will typically ask for monthly reporting, but you can also try to negotiate annual reporting. If your landlord makes you report, you can also try to negotiate and ensure that you will not be penalized if you forgot to report or don't report on time. Remember that everything needs to be in your lease. If it is not in your lease, it does not exist.
The key to negotiating these clauses is to strike a balance that aligns with both parties' interests. Entrepreneurs should fully understand their business needs and seek professional advice to negotiate a lease that best supports their business model and growth plans. Similarly, landlords need to assess their risk tolerance and consider the wider impact of these clauses on their property's value and leasing strategy.
In conclusion, use clauses and exclusive rights in commercial real estate retail leases have profound implications for both landlords and tenants. Understanding and strategically negotiating these terms can help to foster a mutually beneficial business relationship while ensuring the sustainability and profitability of the lease for both parties.
Balancing the business's needs and growth plans with the lease's terms and conditions requires a thorough understanding of these clauses and careful consideration. By adopting a strategic and well-informed approach, entrepreneurs can secure leases that serve their business interests well into the future. Meanwhile, landlords can maintain a diversified and stable tenant base that supports their property's value and long-term profitability. The dynamics of use clauses and exclusive rights offer a compelling facet of commercial leasing strategy that underlines the importance of legal advice and careful negotiation in ensuring successful entrepreneurial ventures in the retail landscape.
